Think Twice Before You Invest in a Private-Equity Fund – Barron’s
Posted: February 27, 2020 at 7:42 pm
Have individual investors missed out by not having access to private equity? In weeks like these, when publicly traded stocks are getting clobbered, it might seem so.
Were about to find out the answer, courtesy of Vanguard Groups recent decision to create a private-equity fund. Though the fund initially will be available only to institutions such as college endowments and nonprofit foundations, Vanguard says it eventually will be made available to individuals as well.
Private equity, of course, refers to equity investments in companies that arent publicly traded. Because these investments usually are sizable, their holding period can be many years, and the risk of failure isnt insignificant. They typically are made by private-equity firms that pool the resources of wealthy and well-connected individuals and institutions. There usually is a very high minimum to invest in these firms, which charge hefty fees, typically 2% of assets under management and 20% of profits.
Even after taking such hefty fees, however, many PE funds have delivered outsize returns to their investors and helped to cement the reputations of many investing gurus. One that many investors are familiar with is David Swenson, who has managed Yale Universitys endowment since 1985 and been a strong proponent of alternative investments generally and private equity in particular. According to Yale, Swenson has produced a return that is unequalled among institutional investors.
Until now, about the only investment options for individuals wanting to get exposure to private equity were the stocks of those few PE firms that are publicly traded, such as KKR (ticker: KKR) and Blackstone Group (BX). Another option has been those exchange-traded funds that invest in a basket of such publicly traded PE firms, such as Invesco Global Listed Private Equity (PSP), with a 1.78% expense ratio, and ProShares Global Listed Private Equity (PEX), with a 3.13% expense ratio.
Many of the details of Vanguards new fund have yet to be made public, such as when the fund will become available, the minimum investment amount, the fees that would be charged, and how long investors would be required to tie up their assets. Vanguard declined a request to provide those details. The new fund will be run via a partnership with HarbourVest, a private-equity firm.
Here are some considerations to keep in mind if and when you are given the chance to invest in Vanguards new fund.
Fees. Ludovic Phalippou, a professor of financial economics at Oxford University, told Barrons that hes worried about the layers of fees that potentially could be charged by this new fundas many as three, in fact: From the PE funds in which HarbourVest invests, from HarbourVest itself, and by Vanguard.
With that many layers of fees, he adds, this new fund would be a nail in Vanguards purpose coffin, since the firm was founded by Jack Bogle with the goal of minimizing fees.
Does private equity beat public stock markets? The answer to this question may very well be no, says Erik Stafford, a professor of business administration at Harvard Business School. He bases his skepticism on the disappointing performance of the largest category of PE funds, so-called buyout funds, which purchase publicly traded companies and take them private.
To be sure, he says, the average PE buyout fund has outperformed the S&P 500 index. But thats an inappropriate comparison, since the typical PE buyout firm invests in companies that are in the so-called small-value category. These are stocks of companies with small market caps that trade for low ratios of price to earnings, book value, return on equity, cash flow, and so forth. Such stocks are at the opposite ends of the size and growth-value spectra from the S&P 500.
According to Stafford, the average PE buyout fund has lagged an index of small value stocks. Oxfords Phillapou said that his research has reached the same conclusion.
Take a look at the accompanying chart, courtesy of data from Nicolas Rabener, founder of the London-based firm FactorResearch. Over the past three decades, private equity has significantly outperformed the S&P 500, but it has significantly lagged a hypothetical index fund of small-cap value stocks. (For private equitys performance, Rabener relied on the Cambridge Associates U.S. Private Equity Index, which is compiled from more than 1,500 institutional-quality buyout, growth equity, private equity energy, and subordinated capital funds formed between 1986 and 2019.)
To be sure, not all researchers agree. Greg Brown, a finance professor at the University of North Carolina at Chapel Hill and director of its Frank Hawkins Kenan Institute of Private Enterprise, told Barrons that his and others research has found that, on an apples-to-apples comparison basis, PE beats public equities by an annualized margin, or alpha, of about 3%.
Though you neednt take sides in this disagreement, its very existence should give you pause. If PEs much-vaunted alpha is so dependent on methodological complexities in its measurement, then perhaps it isnt something you should be so eager to pursue.
Does private equity really have a low correlation with the stock market? Even if PEs alpha is zero, it still could play a valuable role in a diversified portfolioprovided its returns are uncorrelated with those of publicly traded equities.
In that case, a stock portfolio divided between public and private equities should produce long-term performance that is just as high as public market equities alone, but with less volatility or risk. That would enable a risk-averse investor to allocate more to equities than he or she would otherwise be comfortable with.
At first blush, as you can see from the accompanying chart, PE certainly appears to be uncorrelated with public equities. Unfortunately, appearances can be deceiving: The apparently low correlation is largely an artifact of the illiquid securities in which PE funds invest. Those funds have a lot of discretion in deciding how to value them each month or quarter, and the inevitable result, according to Rabener, is that their returns appear to be smoother over time than they really are. He says hes confident that, if there were any way to value PE funds as frequently as publicly traded firms, they would be just as volatile (if not more so).
Is there a illiquidity premium? Some argue that, according to investment theory alone, PE funds should outperform public equities because of their illiquidity. These theorists are referring to the lengthy lockup period that PE funds place on assets invested in them. Investors should receive a higher return as compensation for not having instant access to their assetsan illiquidity premium, if you will.
Or so the theory goes.
But Cliff Asness, founding principal at AQR, argues its possible that not only is there no such premium but there actually may be an illiquidity discount. His argument is that investors are willing to accept a lower return in PE because its high volatility is hidden from plain view. Publicly traded equities, in contrast, smack you in the face with their day-to-day volatility, so they are the ones deserving of the higher return.
In a recent blog post, Asness mused: What if many investors actually realize that...illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns?...What if investors are simply smart enough to know that they can take on a lot more risk (true long-term risk) if its simply not shoved in their face every day (or multi-year period!)?
Professor Stafford agrees. He said that PEs illiquidity premium, which has been much ballyhooed by PEs cheerleaders, is actually zero or even negative.
The bottom line: A completely rational, unemotional investor might very well choose to invest in a portfolio of publicly traded small-cap value stocks rather than in PE. But if you are unable to live with this portfolios volatility and downside losses, and therefore are the kind of investor who ends up throwing in the towel at the bottom of bear markets, you may end up worse off than if you instead invested in a statistically inferior PE fund whose volatility is hidden and with which you can actually live through thick and thin.
So the absence of an illiquidity premium isnt an automatic reason to avoid private equity. But if thats why investors are favoring PE funds, Asness argues, they should be open-eyed about what they are doing.
Mark Hulbert is a regular contributor to Barrons. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.
See the rest here:
Think Twice Before You Invest in a Private-Equity Fund - Barron's
- 'Markets are on a vodka-Red Bull': Behavioral investing analyst on his top 3 concerns about Reddit-fueled trading - CNBC - February 6th, 2021
- Investment bank Greenhill pulls forward revenue to give results a boost - Crain's New York Business - February 6th, 2021
- More bubbles, less shorting. What the GameStop craziness could mean for the future of investing - CNBC - February 6th, 2021
- Alabama-based Acclinate selected for international investment, innovation program - Alabama NewsCenter - February 6th, 2021
- Buick's Nine-Year Investment In Tiger Woods Was Ruinous For Everyone Except Golf - Jalopnik - February 6th, 2021
- The Lesson Of GameStop: Investing Is Not A Game - Forbes - February 6th, 2021
- 4 Unstoppable Growth Stocks to Invest in Right Now - Motley Fool - February 6th, 2021
- Gov. Wolf's Plan to Invest Billions in Education, Cut Taxes for Working Families Draws Praise - pa.gov - February 6th, 2021
- Tackle These 3 Investing Myths Before You Make the Wrong Play - The Motley Fool - February 6th, 2021
- Bill Gates Says This Simple Formula Tells You Exactly How to Invest in Green Energy - Inc. - February 6th, 2021
- Two new efforts could widen the pool of people investing directly in venture funds - TechCrunch - February 6th, 2021
- Ready to Invest? Here's How to Get Started - Morningstar.com - February 6th, 2021
- How Forward-Thinking Investments Will Build the Future of Digital Government - Nextgov - February 6th, 2021
- Letters to the Editor: Lowell Votes responds; Invest in cultured-meat - Lowell Sun - February 6th, 2021
- Want Income? Here Are the Best Ways to Invest in Agriculture - The Motley Fool - February 6th, 2021
- After years of work, MEP finds success in netting opportunity zone investments - Missoula Current - February 6th, 2021
- PayPal is investing in a new business unit focused on crypto and digital currencies - The Block Crypto - February 6th, 2021
- HAGENS BERMAN, NATIONAL TRIAL ATTORNEYS, Alerts Clovis Health Investments (CLOV) Investors: CLOV Admits Prior Knowledge of Undisclosed DOJ Inquiry... - February 6th, 2021
- State bonding bill prioritizes investment in Communities of Color - MSR News Online - December 5th, 2020
- It will be a good end to 2020, Ally Invest's top investment strategist says - CNBC - December 5th, 2020
- What it means to invest in U.S. vs. Canadian cannabis stocks - CNBC - December 5th, 2020
- RioCan Real Estate Investment Trust Announces One-third Reduction in Distributions to Unitholders - GlobeNewswire - December 5th, 2020
- A beginners guide to value investing everything you need to know - CNBC - December 5th, 2020
- Startup Spotlight: Investment deal flow to startups dropped during early stages of pandemic, but is now recovering, report finds - Richmond.com - December 5th, 2020
- 3 ways buying an investment property is different from buying a home, according to a landlord who knows - Business Insider - December 5th, 2020
- SHAREHOLDER ALERT: Pomerantz Law Firm Reminds Shareholders with Losses on their Investment in Wells Fargo & Company of Class Action Lawsuit and... - December 5th, 2020
- About 150 Cadillac dealers take GM buyouts rather than invest in EVs - CNBC - December 5th, 2020
- COVID-19 Update: Vaccines, Treatments And Lockdowns, Investment Implications - Seeking Alpha - December 5th, 2020
- 'Turkey to see more investment flow over next 5 years' | Daily Sabah - Daily Sabah - December 5th, 2020
- The stock markets roller-coaster year exemplifies why staying invested pays off - CNBC - December 5th, 2020
- This family bet everything on bitcoin when it was $900 and bought more when it crashed in 2018 - CNBC - December 5th, 2020
- 3 Reasons a Roth IRA Is Better Than a 401(k) - The Motley Fool - December 5th, 2020
- CNO: Navy Will Have to Convince Biden Administration to Invest in Larger, Lethal Fleet - USNI News - December 5th, 2020
- Dallas-based Jacobs investment puts $2.4 billion value on innovation firm - The Dallas Morning News - December 5th, 2020
- Porsche investing $24 million in 'e-fuels' to supplement electrification of sports cars - CNBC - December 5th, 2020
- Why Ethereum and Bitcoin Are Very Different Investments - CoinDesk - CoinDesk - December 5th, 2020
- Developer Aims to Raise $1 Billion for Investing in Minority Communities - The Wall Street Journal - December 5th, 2020
- Investing in the Future of Food: Pandemic slows investment dealmaking, but also opens opportunities - FoodNavigator-USA.com - November 25th, 2020
- This Is Not Your Father's Alternative Investment - RealMoney - November 25th, 2020
- Red White & Bloom Announces Participation in Upcoming Investment Conferences - GlobeNewswire - November 25th, 2020
- How to refinance a rental or investment property - Fox Business - November 25th, 2020
- Climate Action: Why We Must ALL Invest In Solutions To Save Our Planet - Forbes - November 25th, 2020
- Growth investing: Strategy overview and tips to get started - Business Insider - Business Insider - November 25th, 2020
- Rishi Sunak sets out 100bn investment in infrastructure - The Guardian - November 25th, 2020
- Africa is the biggest investment opportunity the US is missing out on - TRT World - November 25th, 2020
- Investors say they lost thousands with Oceanside investment company - 10News - November 25th, 2020
- 5 Home Improvement Projects With the Highest Return on Investment - Motley Fool - November 25th, 2020
- Dion Dawkins giving the Bills a solid return on investment - Buffalo News - November 25th, 2020
- Germany Further Aligns Foreign Direct Investment Screening Regime with EU Regulation - JD Supra - November 25th, 2020
- Why the only place you should invest in bitcoin is in your IRA - MarketWatch - November 25th, 2020
- Global Investing Giants Are Making Their Post-Covid Stock Bets - Yahoo Finance - November 25th, 2020
- ETFs with Heart...and Returns: ESG Investing into 2021 - ETF Trends - November 25th, 2020
- Looking to Invest in Mining Stocks? These 3 Could Be Great Buys. - The Motley Fool - November 25th, 2020
- UK announces biggest military investment in 30 years - CNBC - November 25th, 2020
- College 101: Understanding Investment Terms and Alternative Investment Options - Daily Cardinal - November 3rd, 2020
- Weitzman hires key executive to grow its investment property operations - The Dallas Morning News - November 3rd, 2020
- Bye Aerospace Gets Investment from South Korean Aerospace9 - Aviation Today - November 3rd, 2020
- Should You Start Your War-on-Cash Investment Basket With Visa? - Motley Fool - November 3rd, 2020
- This Is What Your First Real Estate Investment Should Be - Motley Fool - November 3rd, 2020
- Gladstone Investment Corporation Reports Financial Results for its Second Quarter Ended September 30, 2020 - Yahoo Finance - November 3rd, 2020
- Birdsboro Trailer Manufacturer Wins Fund Investment - The Post - The Sanatoga Post - November 3rd, 2020
- Want $50000 in Retirement Income? Here's How to Get It. - dbrnews.com - November 3rd, 2020
- How has COVID-19 changed the VC investment landscape? - The Burn-In - November 3rd, 2020
- This is why only thrill seekers invest in leveraged ETFs - CNBC - November 3rd, 2020
- More investors believe sustainable investments 'deliver higher returns' - Yahoo Sports - November 3rd, 2020
- Friendlys Will Sell to Investment Group for Less Than $2 Million - Eater - November 3rd, 2020
- Were These Hedge Funds Right About Loading Up On AGNC Investment Corp. (AGNC)? - Yahoo Finance - November 3rd, 2020
- The stock market will be fine: Take a look at this chart - USA TODAY - November 3rd, 2020
- If You Invested $10,000 in Novavax During the Coronavirus Market Crash, This Is How Much Money You'd Have Now - Motley Fool - November 3rd, 2020
- Pfizer to invest 300M, add 300 jobs to expand 3 Irish manufacturing sites - FiercePharma - November 3rd, 2020
- These money and investing tips can help you keep politics separate from your portfolio - MarketWatch - November 3rd, 2020
- Reestablishing American prosperity by investing in the 'Badger Belt' | TheHill - The Hill - October 30th, 2020
- Gov. Wolf Announces Investment of Tax Credits in North Philadelphia to Build Development - pa.gov - October 30th, 2020
- Inslee announces technology investment for Washington students and staff - NBC Right Now - October 30th, 2020
- The best 5G pure-play investment is in cellphone-tower operators - MarketWatch - October 30th, 2020
- Etsy CEO calls this is the 'perfect moment' to invest in marketing - CNBC - October 30th, 2020
- United States Plant Protein Market and Investment Opportunities Report 2020: Consumption in the Country will Increase from US$ 4706.2 Million in 2019... - October 30th, 2020
- Jim Bradley and Patrick Fleming: Put 'investment' into Justice Reinvestment Initiative - Salt Lake Tribune - October 30th, 2020
- Poland Investment Funds and Asset Management Market Report 2020: Focus on Mutual Funds, Insurance, and Pension Assets - GlobeNewswire - October 30th, 2020
- Puhui Wealth Investment Management Co. Ltd. Announces Financial Results for the Fiscal Year Ended June 30, 2020 - PRNewswire - October 30th, 2020